I don’t know a lot about lucid dreaming; and less about its use in Asylum Squad.
But, as I understand it, in non-psychotherapeutic-experimental lucid dreaming, any opponent you meet is actually an aspect of yourself you haven’t mastered. If you conquer it, it will either do something for you you need done, or tell you something you need to know; and will become an ally.
Is this demon a part of Liz she hasn’t yet gained control of? A part that can be useful, but that she hasn’t found the use of?
Or is it just the part of her “madness” that wants to keep her “mad”?